A 401(k) plan is an employer-sponsored retirement savings plan. Contributions are made tax free, and money is allowed to grow in the account tax free. The money is taxed when it is withdrawn, however, and withdrawing before the age of 59.5 will incur a tax penalty.
The method and process of withdrawing money from your 401(k) plan will depend on your employer and the type of withdrawal you choose. Withdrawing money early from your 401(k) can carry serious financial penalties, so the decision should not be made lightly; it's really a last resort.
Not every employer allows early 401(k) withdrawals, so the first thing you need to do is check with your human resources department to see if the option is available. If it is, then you should check the fine print of your 401(k) plan to determine the type of withdrawals that are allowed or available.
As of 2019, if you are under the age of 59½, a withdrawal from a 401(k) is subject to a 10% early withdrawal penalty. You will also be required to pay normal income taxes on the withdrawn funds. For a $10,000 withdrawal, once all taxes and penalties are paid, you will only receive approximately $6,300. There are some non-penalty options to consider, however.
The 401(k) Loan Option
A better option: a 401(k) loan. Instead of losing that portion of your investment account forever—as you would with a withdrawal—a loan allows you to replace the money through payments deducted from your paycheck. You'll have to check if your plan offers loans, as well as if you're eligible.
The Hardship Withdrawal Option
There are some withdrawals that can be taken without a penalty. For example, taking out money to help with economic hardship, to pay college tuition, or to fund a down payment for a first home are all withdrawals that are not subject to penalties, though you still will have to pay income tax, at your regular tax rate.
A distribution from a participant’s elective deferral account can only be made if the distribution is both:
- Due to an immediate and heavy financial need
- Limited to the amount necessary to satisfy that financial need
In some cases, if you left your employer in or after the year in which you turned 55, you may not be subject to the 10% early withdrawal penalty.
Once you have determined your eligibility and the type of withdrawal, you will need to fill out the necessary paperwork and provide the requested documents. The paperwork and documents will vary depending on your employer and the reason for the withdrawal, but once all the paperwork has been submitted you will receive a check for the requested funds—hopefully without having to pay the 10% penalty.